Itâ€™s time, Fellow Reckoner…time to announce the winner of this yearâ€™s â€œThe-name-of-the-guy-who-came-up-with-the-idea-of-evolution-but-whoâ€™s-name-we-cannot-use-due-to-trademark-infringement-constraints-Award!â€

Or, for short…

The winner of our inaugural Daily Reckoning Dodo Derby.

Letâ€™s start where all good evolutionary tales start: at the beginning…

This year, 44 of Americaâ€™s united states will deliver a combined 2012 budget shortfall of approximately $125 billion. They are broke, in other words, and determinedly bureaucratizing themselves ever closer to outright insolvency…the financial equivalent of the dinosaursâ€™ tar pit.

By way of honoring their commitment to financial evolution â€“ that is, by rendering themselves extinct so that newer, more adaptive and innovative concepts of trade and freedom can take their place â€“ we featured a handful of these states during recent Daily Reckoning musings.

First, in last weekendâ€™s edition, we narrowed the field to ten finalists â€“ California, Connecticut, Illinois, Louisiana, Massachusetts, Mississippi, New Jersey, New York, Ohio and Wisconsin.

Then, on Monday and Tuesday, we awarded special mentions to Connecticut and New Jersey for their commitment to wasteful state government spending. Next, we bestowed first and second runners-up honors on California and Massachusetts, respectively.

Total state debt per man woman and child â€“ whether working or not: $11,138!

Yes, Fellow Reckoner, this yearâ€™s winning state, occasionally referred to as Land of Lincoln or The Prairie State, home of the president of the country with the largest total debt the world has ever seen, is…

Illinois.

Congratulations Illinois. Here are your residents:

â€œI think Iâ€™ll chime in,â€ begins our first Reckoner, kicking things off. â€œI live in Illinois and, like Wisconsin, our day of reckoning will be coming soon. Picking on the middle class will result in a mutiny of grand proportions.

â€œStart taking a look at the School Boards where they vote themselves raises and plum retirement benefits… The politicians and judges who get automatic raises each year or ever other year… The City Councils who bicker of not making enough… The special stipends these people get so they can hire family members… Raises and promotions for those who have contributed to the funds of those running for re-election… Get with the State Comptrollerâ€™s Office and investigate who gets what in payroll. Politicians SHOULD also increase their contribution to Health Care. Eliminate state positions that crossover and are duplicating waste and make sure that all building contracts come within budget. Reduce and/or eliminate nepotism within state offices.â€

And hereâ€™s reckoner Bob, with a few specific tales of local waste…

â€œHere in Chicago IL, at Piotrowski Park, they demolished a nice playground area and replaced it with a greatly inferior playground. Then, in the field house, they installed an elevator that goes from the ground floor to the locker room one floor below, as if the stairs were not enough. Oh…and they tore out the field house reception area just so they could rebuild it. In the playing field, they tore out perfectly good water fountains just to replace them.â€

Adds Reckoner Charles…

â€œI live in Illinois too, where instead of postponing two overpasses across the railroad tracks, they are going ahead with it. That would cut costs buy over $2,000,000 just by putting it off for a while. The overpasses are NOT needed. Just that some council person wants a few more votes.â€

And this, from Reckoner John…

â€œIllinois has an interesting strategy for funding teacher salaries and retirement. Illinois schools and teacher salaries are funded by property taxes, but the taxes remain in the community where they are collected. There is no statewide distribution. The rich get richer…

â€œThen there are the pensions. The Illinois Taxpayers Union has lists of the top 100 educator pensions on a county-by-county basis. In Cook County, the top 100 pensions run from $238K to $146K annually. Pensions range from 60% to 120% of the average salary for the last four years of employment. These are for primary and secondary educators in suburban Cook County. An â€˜educatorâ€™ from the National Education Association is #2 on the list at $235K.

â€œThe top 100 Community College educator pensions in Cook County have a slightly lower range â€“ $208K-$102K. Guess who picks up the tab for pensions?â€

And finally, an appropriately named Reckoner â€œCostâ€ sounds off…

â€œThey are now going after the residents for online purchases made from retailers located outside the state with no in-state presence, but used/consumed within the state, to the tune of a 6.25% tax rate. Ludicrous. And they are offering amnesty going back to 2004 along with the option of using the estimated tax table if you donâ€™t have records. The tables are heavily skewed to the Stateâ€™s favor (assuming, for example, that if your gross income was $75-100K, you would have spent $1,000 online for such purchases.) Keep in mind, though, that this is the State that also lets residents voluntarily pay cigarette taxes for purchases made outside the State. Go Illinois!â€

Go Illinois, indeed.

Thanks again to the hundreds of readers who wrote in from around the nation will tales of waste and incompetence at their individual state levels. And congratulations again to our finalists and, of course, this yearâ€™s winner.

The Daily Reckoning is a contrarian e-letter, brought to you by New York Times best-selling authors Bill Bonner and Addison Wiggin since 1999. The DR looks at the economic world-at-large and offers its major players – investors, politicians, economists and the average consumer – some much-needed constructive criticism.

JUPITER, Florida (February 7, 2011) â€” On Friday, regulators closed three banks: Community First Bank Chicago, Chicago, Illinois; North Georgia Bank, Watkinsville, Georgia and American Trust Bank, Roswell, Georgia. This brings the total number of U.S. bank and thrift failures to 14 for 2011.

Community First Bank Chicago, Chicago, Illinois with assets of just over $56.9 million at September 30, 2010 had been rated E- (“Very Weak”) for the last four quarters by Weiss Ratings and was first identified as “Weak” in April 2006 based on fourth quarter 2005 data, its first reporting period as the bank was established in November 2005. It reported a loss of more than $1.3 million through September 30, 2010. Community First had below-FDIC-mandated Tier 1 (5%) and Risk-Based Capital (6%) ratios of 2.76% and 4.78%, respectively.

Nonperforming loans made up just over 5% of its loan portfolio. Northbrook Bank and Trust Company based in Northbrook, Illinois with assets of $1.1 billion and a Weiss Rating of “D” will assume the deposits of Community First Bank Chicago.

North Georgia Bank, Watkinsville, Georgia, east of Atlanta, with assets of $166.3 million at September 30, 2010 had been rated E- (“Very Weak”) for the last six quarters by Weiss Ratings and was first identified as “Weak” in June 2008 based on first quarter 2008 data. The bank reported a loss of $4.8 million through September 30, 2010. North Georgia had below-FDIC-mandated Tier 1 (5%) and Risk-Based Capital (6%) ratios of 2.20% and 4.48%, respectively.

Nonperforming loans represented almost 30% of its loan portfolio. BankSouth based in Greensboro, Georgia with assets of $249.5 million and a Weiss Rating of “D+” will assume the deposits of North Georgia Bank.

American Trust Bank, Roswell, Georgia, north of Atlanta, with assets of just over $249.2 million at September 30, 2010 had been rated E- (“Very Weak”) for the last six quarters by Weiss Ratings and was first identified as “Weak” in January 2008 based on third quarter 2007 data. The bank reported a loss of more than $4.8 million through September 30, 2010. American Trust had below-FDIC-mandated Tier 1 (5%) and Risk-Based Capital (6%) ratios of 2.23% and 4.19%, respectively. Charged-off loans made up just over 2% of its loan portfolio. Renasant Bank based in Tupelo, Mississippi, with assets of $4.2 billion and a Weiss Rating of “D+” will assume the deposits of American Trust Bank.

Weiss Ratings, the nation’s independent provider of bank and insurance company ratings, accepts no payments for its ratings from rated institutions. It also distributes independent ratings on the shares of thousands of publicly traded companies, mutual funds, closed-end funds and ETFs.

Last week I received an e-mail solicitation that was both hilarious and sad. It came from a broker trying to sell municipal bonds from Illinois. He touted them as “investment grade” and was impressed by the tax-free 5.6 percent yield.

This is absurd, of course, as you know if you’ve been reading Money and Markets regularly. Cities and states everywhere are in dismal financial condition. Illinois is among the worst of the lot. A ratings agency called Illinois bonds “investment grade” only because the entire issuer-financed ratings system is corrupt.

Needless to say, I didn’t take the bait.

Here is a tip that will serve you well in your investing: If an offer sounds too good to be true, it probably is. Right now, just about anything that offers a “safe” 5.6 percent yield is either a complete scam or far riskier than it looks on the outside. Don’t fall for it.

Muni bonds can help keep your tax bill down.

Now I’m not saying that all municipal bonds are always useless. They can make sense for wealthy people in high tax brackets. They may even fit as a small slice of a retired person’s income portfolio.

But you need to be aware of the risks, because …

Not All Muni Bond ETFs
Are Created Equal

Like they do in many other segments, exchange traded funds (ETFs) are often the better way to go if you want to own municipal bonds. You get the advantages of diversification and liquidity in one package.

Why is this important?

The idea of a local government going bankrupt used to be unthinkable. For states, it has long been thought impossible. But now more than ever, municipal bonds carry significant credit risk.

The governmental bodies — such as cities, states, school districts, and water departments — that issue these bonds are suffering in this weak economy. Often they’re saddled with unsustainable union contracts and huge pension obligations.

So what happens if, in your quest for lower taxes and higher yields, you own a portfolio of muni bonds from a troubled state like Illinois — which then goes bankrupt? Instead of a juicy yield, you may find you’re holding a massive loss.

ETFs offer at least a partial solution to this problem — or at least some ETFs do. Muni bond ETFs run the gamut from highly speculative to fairly safe, along with everything in between.

First, let’s take a look at a couple of ETFs I wouldn’t touch with a ten-foot pole …

Investors could be left with nothing if their muni bonds default.

Muni ETF #1 to Avoid: PowerShares Insured National Muni Bond (PZA)

Ahh, that comforting word “insured.” No need to worry — the insurance company is there to take care of you. Well, no, not exactly.

Bond insurance is supposed to protect investors against default. If the issuer can’t pay you back, the insurance company will. That’s assuming it even exists when the bill comes due.

PZA specializes in these kind of muni bonds — the ones that look safe but really aren’t. Even more amazing, insured munis tend to pay below-average yield because of the supposed “guarantee.” For some reason, people believe it. They’ve made PZA one of the largest and most actively-traded muni bond ETFs.

Some shiny things aren’t worth much.

My take: PZA is fool’s gold. Don’t be fooled by the glitter. Just keep moving downstream.

Muni ETF #2 to Avoid: Market Vectors High-Yield Municipal (HYD)

In bond lingo, “high-yield” is a polite way of saying “junk.” HYD is a junk-muni ETF. It holds a portfolio of bonds that can’t qualify as investment grade even under the laughably low standards of the major rating agencies. They really are junk!

Because it is an ETF, HYD is diversified among many different junk munis … but they’re still junk. They have high yields for a very good reason: These bond issuers are more likely to default.

Sometimes the risk of default is outweighed by higher potential returns. In my opinion, now is not one of those times. Stay away from HYD.

Now, let’s spotlight …

A Muni ETF That Is Worth a Second Look: Market Vectors Pre-Refunded Municipal (PRB)

A “pre-refunded municipal” is an interesting little niche. When interest rates drop, borrowers like to refinance. You may have done this with your home mortgage. However, unlike your mortgage, most muni bonds can’t be retired just because they’ve been replaced by new, lower-rate bonds.

Advertisement

So states and cities use the proceeds from a new bond sale to buy Treasury securities matched to the “call date” of the original bond. These are then held in escrow to pay off the original bonds.

That means if you own those original bonds, what you really own is a portfolio of U.S. Treasury securities. The yield is still tax-free because they are wrapped inside a municipal package. But you are no longer exposed to the local government’s default.

PRB holds a portfolio of these bonds.

Right now the average maturity is 3-4 years. The yield, which is free of Federal taxes, is about 1.1 percent. If you’re in the top tax bracket (35 percent), the taxable equivalent yield is around 1.7 percent. That’s hard to beat at such a low level of risk.

As you can see, muni bond ETFs come in all shapes and forms. Some are potentially very dangerous. Others, like PRB, can be very attractive. So do your homework before jumping in.

Best wishes,

Ron

P.S. Are you looking to profit from ever-changing global market conditions by identifying which ETFs have the most profit potential at any given time? Then be sure to check out my International ETF Trader.

Last week I received an e-mail solicitation that was both hilarious and sad. It came from a broker trying to sell municipal bonds from Illinois. He touted them as “investment grade” and was impressed by the tax-free 5.6 percent yield.

This is absurd, of course, as you know if you’ve been reading Money and Markets regularly. Cities and states everywhere are in dismal financial condition. Illinois is among the worst of the lot. A ratings agency called Illinois bonds “investment grade” only because the entire issuer-financed ratings system is corrupt.

Needless to say, I didn’t take the bait.

Here is a tip that will serve you well in your investing: If an offer sounds too good to be true, it probably is. Right now, just about anything that offers a “safe” 5.6 percent yield is either a complete scam or far riskier than it looks on the outside. Don’t fall for it.

Muni bonds can help keep your tax bill down.

Now I’m not saying that all municipal bonds are always useless. They can make sense for wealthy people in high tax brackets. They may even fit as a small slice of a retired person’s income portfolio.

But you need to be aware of the risks, because …

Not All Muni Bond ETFs
Are Created Equal

Like they do in many other segments, exchange traded funds (ETFs) are often the better way to go if you want to own municipal bonds. You get the advantages of diversification and liquidity in one package.

Why is this important?

The idea of a local government going bankrupt used to be unthinkable. For states, it has long been thought impossible. But now more than ever, municipal bonds carry significant credit risk.

The governmental bodies — such as cities, states, school districts, and water departments — that issue these bonds are suffering in this weak economy. Often they’re saddled with unsustainable union contracts and huge pension obligations.

So what happens if, in your quest for lower taxes and higher yields, you own a portfolio of muni bonds from a troubled state like Illinois — which then goes bankrupt? Instead of a juicy yield, you may find you’re holding a massive loss.

ETFs offer at least a partial solution to this problem — or at least some ETFs do. Muni bond ETFs run the gamut from highly speculative to fairly safe, along with everything in between.

First, let’s take a look at a couple of ETFs I wouldn’t touch with a ten-foot pole …

Investors could be left with nothing if their muni bonds default.

Muni ETF #1 to Avoid: PowerShares Insured National Muni Bond (PZA)

Ahh, that comforting word “insured.” No need to worry — the insurance company is there to take care of you. Well, no, not exactly.

Bond insurance is supposed to protect investors against default. If the issuer can’t pay you back, the insurance company will. That’s assuming it even exists when the bill comes due.

PZA specializes in these kind of muni bonds — the ones that look safe but really aren’t. Even more amazing, insured munis tend to pay below-average yield because of the supposed “guarantee.” For some reason, people believe it. They’ve made PZA one of the largest and most actively-traded muni bond ETFs.

Some shiny things aren’t worth much.

My take: PZA is fool’s gold. Don’t be fooled by the glitter. Just keep moving downstream.

Muni ETF #2 to Avoid: Market Vectors High-Yield Municipal (HYD)

In bond lingo, “high-yield” is a polite way of saying “junk.” HYD is a junk-muni ETF. It holds a portfolio of bonds that can’t qualify as investment grade even under the laughably low standards of the major rating agencies. They really are junk!

Because it is an ETF, HYD is diversified among many different junk munis … but they’re still junk. They have high yields for a very good reason: These bond issuers are more likely to default.

Sometimes the risk of default is outweighed by higher potential returns. In my opinion, now is not one of those times. Stay away from HYD.

Now, let’s spotlight …

A Muni ETF That Is Worth a Second Look: Market Vectors Pre-Refunded Municipal (PRB)

A “pre-refunded municipal” is an interesting little niche. When interest rates drop, borrowers like to refinance. You may have done this with your home mortgage. However, unlike your mortgage, most muni bonds can’t be retired just because they’ve been replaced by new, lower-rate bonds.

Advertisement

So states and cities use the proceeds from a new bond sale to buy Treasury securities matched to the “call date” of the original bond. These are then held in escrow to pay off the original bonds.

That means if you own those original bonds, what you really own is a portfolio of U.S. Treasury securities. The yield is still tax-free because they are wrapped inside a municipal package. But you are no longer exposed to the local government’s default.

PRB holds a portfolio of these bonds.

Right now the average maturity is 3-4 years. The yield, which is free of Federal taxes, is about 1.1 percent. If you’re in the top tax bracket (35 percent), the taxable equivalent yield is around 1.7 percent. That’s hard to beat at such a low level of risk.

As you can see, muni bond ETFs come in all shapes and forms. Some are potentially very dangerous. Others, like PRB, can be very attractive. So do your homework before jumping in.

Best wishes,

Ron

P.S. Are you looking to profit from ever-changing global market conditions by identifying which ETFs have the most profit potential at any given time? Then be sure to check out my International ETF Trader.

â€œTop Illinois Democrats have agreed to push a plan that would temporarily boost income taxes by 75 percent and double cigarette taxes,â€ harked CBS Chicago on January 6, 2011. The proposed plan would increase Illinoisâ€™ personal income tax rate from 3 percent to 5.75 percent for the next three years. After that, it would drop back to 3.25%. So they say.

Illinois is a state in which the legislators have so betrayed the taxpayers that a lifetime on Devilâ€™s Island would be too good for them. For instance, the liability of the four state pension plans is calculated at $151 billion or $280 billion, depending on the assumptions used. The $280 billion figure is analytically controversial but deductively compelling given the efforts to deny and confuse bondholders and the public alike respecting the coming collapse of the municipal bond market.

Springfield, the capital of Illinois, is a nice town. As state capitals go, it is strikingly uninhabited with a population of 110,000 (and falling, but not as fast as its benefit obligations are rising). Farm country starts about three blocks from the state house. Illinois has more representation in its capital than any other state.

The politicians raised pension benefits faster than poker bids in Macau. Presumably, they have boosted their own benefits faster than the stateâ€™s public servants, who, once they retire, no longer pay one cent for health insurance.

Clay ducks would have done better at funding promises than the elected representatives. There are $70 billion of assets to support the $280 billion of pension obligations (See The Liabilities and Risks of State-Sponsored Pension Plans in which Professors Novy-Marx and Rauh lay forth their provocative and engaging argument).

Illinois borrows from the bond market each year to pay benefits, a total of $16 billion since 2007. Bondholders have been paid $550 million (on the first $10 billion) for funding this pyramid scheme. In other words: Illinois taxpayers have paid a $550 million late-fee that, if there were justice in this world, would be paid by the Illinois legislators.

These legislators â€“ and this is true across the country, not just Illinois â€“ cannot conceive of a time when there will be no buyers of bonds to pay benefits that the politicians failed to fund. By borrowing to meet current payments, the â€œtop Illinois Democratsâ€ have fostered the national charade of limitless taxing authority. State General Obligation (G.O.) bonds are backed by the â€œfull faith and creditâ€ phrase, stamped on their offerings. Wall Street research would have it that a G.O. bondholder can take that phrase to the bank. It is from this precipice that bondholders hang by their fingernails.

Goldman Sachs research chips in: â€œ[G]eneral obligation debt is backed by a state or local governmentâ€™s pledge to raise taxes to service that debt if necessary.â€ Barclayâ€™s wrote to its California-averse clients that the state is obligated â€œin good faith to use its taxing power as may be required for the full and prompt payment of debt service.â€

There are four problems here.

First, the State of Illinois had accumulated over $5 billion of unpaid bills by the end of 2010. Electricity to the governorâ€™s mansion will be cut off if the politicians donâ€™t grow up.

Second, the authority to raise taxes to meet bond payments often does not work. The most recent instance is the State of Oregon. In early 2010, voters increased tax rates on high earners and businesses to fill a $700 million deficit. Civil servants danced in the streets: â€œWeâ€™re absolutely ecstatic,â€ said Hanna Vandering, a physical education teacher from Beaverton and vice president of the statewide teachers union. â€œWhat Oregonians said today is they believe in public education and vital services.â€ (The Oregonian, January 26, 2010) On December 16, 2010, the state of Oregon had received one-third less than was expected from windfall tax receipts. Those Oregonians who werenâ€™t talking while Hanna Vandering was spouting decided they would rather leave town than contribute to this scandalous love-in between legislators and public unions.

Third, the authority and inclination of courts to issue a writ of mandamus (ordering state officials to raise taxes) is not a topic discussed in brokerage firm research. It is hereby suggested to municipal bondholders who are recipients of such reports to ask why this is so. There have been many decisions in which the court concluded it did not have the authority (or inclination: because efforts, such as in Oregon, are generally unsuccessful) to demand tax increases. The decisions are too varied to discuss here. (See, as a start, Tax Increases in Municipal Bankruptcies, Kevin A. Kordana, Virginia Law Review, volume 83, No. 6, pp. 1035-1107.) Readers may recall that states cannot file for bankruptcy. This is true, but an insolvent body that reneges on its obligations to bondholders will sit in the dock. Municipal decisions are the obvious precedents for the courts.

Fourth, a Sword of Damocles hovers over all transactions and contracts in the United States today: who still trusts the â€œfull faithâ€ of any government body? And, this is the worst situation of all: politicians who think they can fly.

Illinois is No Peter Pan originally appeared in the Daily Reckoning. The Daily Reckoning, offers a uniquely refreshing, perspective on the global economy, investing, gold, stocks and today’s markets. Its been called “the most entertaining read of the day.”

The Daily Reckoning is a contrarian e-letter, brought to you by New York Times best-selling authors Bill Bonner and Addison Wiggin since 1999. The DR looks at the economic world-at-large and offers its major players – investors, politicians, economists and the average consumer – some much-needed constructive criticism.